Saturday, June 08, 2013

why hold bonds at all?

With expectations of higher interest rates, the risks to many fixed
income investments have risen. This has been widely publicized, and we
have discussed these risks in the past. Bond bears point out that yields
are near forty-year lows and if interest rates rise, the value of bonds
and bond funds will fall. And some well known investors such as Warren
Buffett have advocated selling bonds and just holding a mix of cash and
equities. Nonetheless, we think bonds should still play an important role in an overall portfolio. Here are some reasons.

Diversification and reduced volatility: One of the primary
reasons to have an allocation to fixed income is for the diversification
it provides in an overall portfolio. Historically, bonds have tended to
move up in price when stocks and other riskier sectors of the market
decline. When stocks and bond returns are not correlated, investors
benefit by reducing the swings in their portfolios, resulting in lower
volatility. When we looked at times when the S&P 500 experienced
significant declines (we used declines of 14% or more for our study)
since the 1970s, we see that bond returns have generally been positive.

Large negative stock returns have been offset by positive bond returns